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Three years ago, the U.S. SEC proclaimed its intention to quit GAAP standards and shift to IFRS. The proclamation was made tentatively, and the shift has not shown much progress since then. It is feasible to assume the transition was impeded by the sheer dissimilarity of the Principles and the Standards.
IFRS and GAAP constitute two bodies of literature enlisting the principles of accountancy and reporting worldwide and in the U.S., respectively. While IFRS was designed as the unified language of accountancy that would efface the boundaries between the countries of the world, GAAP was developed by Americans and, presumably, for Americans. The differences, however, are not limited to the goals and scope of implementation.
There is a gaping abyss of dissemblance between the Standards and the Principles; over time, an extensive body of fact sheets and other materials has appeared, running for pages and pages to account for every aspect of dissimilarity. The following paper is focused on the consolidation standards that GAAP and IFRS contain. Within the framework of GAAP and IFRS, the differences in consolidation are significant; for example, some of the entities that can be consolidated under GAAP would have likely ceased to be a part of the group under IFRS and vice versa (PwC, 2014).
The Standards and the Principles are fundamentally different in the aspects of general requirements, which include differences in financial statement preparation and accounting policies, and consolidation models, with the focus on the models themselves, the concept of control, and potential voting rights.
Beginning with GAAP, it can be seen that its requirements for consolidation concern preparing financial statements and accounting policies. Generally, within the frames of consolidated financial statements, the economic resources, either tangible or intangible, as well as the liabilities, expenditures, and savings, are accounted for without separating the parent organizations and the subsidiary organizations.
Firstly, as per GAAP standards, preparing financial statements is compulsory. On the other hand, in some cases, the statements are not compulsory for companies whose parent is an investment establishment (PwC, 2014). Secondly, when a financial statement is being prepared, a three-month difference of the end of the financial year between the reporting and consolidated entities is excusable.
Lastly and importantly, if the reporting entity faces some events that have critical effects, they should be recorded in the statement (KPMG, 2014). Such events can include, for example, the discovery of an error that disrupts the correctness of the statement, the discovery of information indicating the imparity of an asset (e.g., that a client went bankrupt), etc. The criticality of such events and their impact on the parent and subsidiaries are the reasons they have to be disclosed as per GAAP. As for the general accounting policies, the parent and subsidiaries can vary in their practices. For instance, they can evaluate inventories using different bases, classify, and present assets under diverse categories, and recognize their assets at diversifying times; such dissemblance is permissible under GAAP (KPMG, 2014).
The next aspect of GAAP’s consolidation that is worth considering is the consolidation model proper. The optimality of the consolidation model determines how the accounting process flow happens on all levels: from recording subsidiary-parent loans and charging payables to closing the parent organization’s books and issuing and reviewing financial statements. GAAP has two consolidation models. To make a consolidation decision, the potential subsidiaries are first to be assessed as to their conformity to the VIE (variable interest entities). If the subsidiaries cannot be accepted as VIE, they are subject to subsequent evaluation through the voting interest model (PwC, 2014). A parent establishment has a VIE as a priority if it is compliant to the following.
First, the parent should have the power to set the direction for the VIE’s activities, including the most economically significant ones. Secondly, the parent should be prepared to shoulder the VIE’’s losses and be in the right to assimilate the benefits. Again, both the losses and the benefits should bear economic significance to the VIE (PwC, 2014). A parent organization can only have one VIE. The rest of the subsidiaries’ value is established through the voting control model, the second one under the GAAP.
Within this model’s framework, potential voting rights are overlooked, with the focus on the actual ones. Importantly, the GAAP standards do not presuppose the existence of de facto control. Instead, the GAAP relies on the concept of effective control that has to deal with contract arrangements; at the same time, such a method of control is comparatively rarely implemented. It means that subsidiaries can be controlled directly or indirectly under GAAP, even if the parent owns fewer than half of the voting rights. Concerning voting rights, they are assessed within the VIE model. For non-VIEs, potential voting rights are unassessed.
Having reviewed the consolidation aspects of GAAP, moving on to those of IFRS would be only logical. The Standards can be reviewed correspondingly from the points of general requirements and consolidation model since these aspects appear to present the most significant points of diversity. Considering the general requirements that IFRS imposes, it is worth stating that the preparation of financial statements is also obligatory.
However, the dates on which the parent establishment and the subsidiaries issue their financial statements should correspond. If reporting on the same date is not possible (or practicable) the financial statements should be based on the most recent issues of the subsidiary establishments. When the dates on which the parent and the subsidiaries report are different, the latter should provide extra statements filled out as of the same date as the former (KPMG, 2014).
However, when the date span does not add up to more than three months, the extra statements are not compulsory. On the other hand, if either a favorable or unfavorable event occurs after the reporting period end and the issuance date, the additional statements are obligatory (PwC, 2014). Concerning the policies, IFRS establishes that a similar transaction conducted by two or more entities should be accounted for using the same accounting policies. The policies should match across the entities for the sake of demonstrativeness and stability. Specifically, the policies and procedures should encompass any measurements and methodologies, etc.
Subsequently, it is worth bringing IFRS’s consolidation model into focus. Keeping in mind the critical significance of a successful consolidation model, one can point out the fact that IFRS has a unified model to consolidate its entities. In a word, the model can be described as control-focused or “power-to-direct” (KPMG, 2014, p. 17). There are three indicators that an investor can direct the investee’s actions.
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First, an investor should be capable of controlling the actions that can impact the investee’s ROIs. Secondly, and more importantly, an investing entity certainly is the one in control if it is exposed to the investee’s ROIs. Finally, using the power to control, an investor should be able to influence the amount of ROIs (KPMG, 2014). As it was stated, the concept of control is at the baseline of IFRS’s consolidation model. The fundamentality of it can be further backed up by the fact that the Standards practice the so-called “de facto control” (PwC, 2014). Generally, a parent is supposed to control the subsidiaries if it owns more than 50% of their voting powers.
De facto control outlined in the Standards subsumes the existence of the parent’s control despite some limitations. These can consist of holding less than half of the voting interest or being unable to exercise a legal or contractual right to direct the subsidiaries’ voting powers (PwC, 2014), for example, if a major stakeholder controls an investee that happens to be a public corporation. Although such a corporation can freely trade its share of stock, its actions are controlled de facto by the major investor (PwC, 2014). As to the potential voting rights, they are bound to be exercisable in a situation that requires decision-making to set the direction for economically significant activities. In other words, the Standards bid the rights to be substantive.
Contrasting GAAP and IFRS
From the abovementioned traits and practices of GAAP and IFRS, one can assume the two consolidation modes show significant diversity in terms of both general requirements and consolidation models. On the general scope, the preparation of financial statements is obligatory to both the Principles and the Standards, with excusable industry-based exceptions. However, there is a discrepancy of approaches to the date span and the submission of additional statements: While GAAP allows the differences in a year ends, IFRS bids the reporting entities to meet their year ends.
In terms of accounting policies, the requirements are diametrically opposite: The Principles do not restrict the policies of the parent and subsidiaries to uniformity, while the Standards do. As to the consolidation model, GAAP’s are bipolar, while IFRS is unified. Contrastingly to the Principles, IFRS does not utilize the VIE entities assessment, and GAAP, unlike the Standards, is not reliant on de facto control. Generally, GAAP is regarded as rules-based, while IFRS is commonly thought to be based on principles. Principles, when clearly defined and practicable, can prove to be valuable assets to consolidation accounting.
The strong points of IFRS include, namely, facilitated decision-making in terms of accounting for and preparing statements. Also, it provides a competitive advantage over the companies conducting similar transactions, industrial areas notwithstanding. The rule-based GAAP’s practices can substantially reduce risks and be competitively advantageous, but the advantage is only gained within the same industry, and the risks are further increased when the rules are not followed to the letter (Which Is Better, 2011).
Although GAAP offers clear ways of application and competitive comparability, there is a fact that speaks to the disfavor of the Principles: IFRS is either obligatory or preferable in dozens of jurisdictions, while GAAP is only used in one. The great diversity both in general requirements and consolidation models might trigger the lagging in adopting IFRS by the U.S., but once adopted, the Standards would certainly change the American accountancy for the better.
KPMG. (2014). IFRS compared to US GAAP: An overview. Web.
PwC. (2014). IFRS and US GAAP: similarities and differences. Web.
Which is Better – Principles or Rules? (2011). Web.